BoE cuts inflation and growth forecasts on China concerns

Forecasts for UK inflation and growth have been downgraded in the Bank of England's quarterly inflation report due to concerns about global growth, especially in China, with consumer price inflation (CPI) expected to be below its 2% target until the end of 2017.

Again keeping monetary policy on hold, the Bank trimmed its CPI forecast for the end of 2015 to 0.1% from 0.3% in August's report and lowered the estimate for the end of 2016 to 1.2% from 1.5%.

In light of weaker global growth since its August report, the Bank lowered its forecasts for the country's gross domestic product growth to 2.7% from the earlier 2.8%, while for 2016 it calculated the UK economy will grow by 2.5%, down from the 2.6% predicted three months ago.

For 2017, the growth forecast was lifted to 2.6% from 2.5%, with the 2018 growth forecast started at 2.5%.

"Recent developments in China have highlighted the challenges faced by the authorities of liberalising and rebalancing the economy... a sharp slowing in China could affect the UK economy through a number of channels, including through trade and financial interlinkages."

While domestic economic momentum remains "resilient", the Bank acknowledged that the outlook for global growth had weakened since the August inflation report, with many emerging market economies having slowed markedly and hence the Monetary Policy Committee has downgraded its assessment of their medium-term growth prospects.

"While growth in advanced economies has continued and broadened, the Committee nonetheless expects the overall pace of UK-weighted global growth to be more modest than had been expected in August. There remain downside risks to this outlook, including that of a more abrupt slowdown in emerging economies."

On the domestic economy, the Bank said with solid consumer confidence, real income growth expected to be the strongest since the crisis and investment intentions remaining robust, demand growth has been solid.

"Although it has moderated, growth is projected to pick up a little towards the middle of next year, as a tighter labour market and stronger productivity support real incomes and consumption, and as accommodative credit conditions encourage strong investment and a pickup in the housing market. The Committee judges the risks to domestic demand to be broadly balanced."

The market interpreted the inflation report and the Bank's statement as dovish relative to what had been priced in immediately before the announcement, sending sterling weaker and resulting in bonds rallying.

After the release of the report, economist Vicky Redwood at Capital Economics said the “Super Thursday” announcements from the MPC were on the whole quite dovish, despite some commentators expecting serial rate dissenter Ian McCafferty to be joined by one or two other members in voting for a hike.

"The MPC has sent a warning to markets that they have lowered their rate expectations too far. The Inflation Report forecasts are based on rate expectations in the 15 working days to 28 October – which at that time, were for the first rate rise to come in Q2 2017. And they show inflation projected to be a bit above the 2% target at the policy horizon.

"Admittedly, market expectations have corrected a bit in the past few days - with the first hike now expected at the end of 2016. But we think that this process has further to go."

Economists at BNP Paribas said one noteworthy change to the language in the statement was that the Bank now aims to return inflation to target “in around two years” rather than “within two years”.

"This change is subtle but is hawkish, as it says the Bank will tolerate somewhat below target inflation at the two year horizon. This is important given it expects inflation to remain below 2% until Q3 2017. Overall, our initial read on the raft of communication is that we do not see a great deal that changes our view of the first rate hike coming in May 2016."